The global financial crisis has led to a profound rethinking of the consensus on monetary policy. Before the crisis, most monetary economists agreed that "flexible inflation targeting"—in which central banks focus on maintaining price stability and stabilizing the output gap—was an appropriate and sufficient mandate for conducting monetary policy. Key assumptions underlying the consensus were that this mandate would automatically lead to financial stability and that the framework of monetary policy could deal with cross-border capital flows.

But the consensus is increasingly seen as inadequate. Monetary economists and central banks have broadened their perspective on financial stability, viewing it as a major concern for the conduct of monetary policy. For example, many central banks are now publishing financial stability reports and other indicators that reflect the state of the financial system.

How much of the precrisis consensus remains valid and how much rethinking of monetary principles is needed? Are central banks right to broaden their goals to include not only inflation targeting but also financial stability? And should they be given an explicit mandate for financial stability, such as targeting the growth of credit and asset prices?

After the crisis, which tools are most appropriate for the conduct of monetary policy and should the goals of inflation targeting and financial stability be pursued using the same tools? If the two goals come into conflict, how should central banks resolve the conflict? And to what extent should central banks be involved in financial regulation?

Proposals

The future of Central Banking could be summarized as: i) Despite the current scenario which is impairing their credibility, the Central Banks will remain the most powerful and influential economic in ...

The future of Central Banking could be summarized as: i) Despite the current scenario which is impairing their credibility, the Central Banks will remain the most powerful and influential economic institution; ii) Presently, there is a transition towards the multiple goal approach, which will include financial stability and, possibly, other objectives as well, such as growth and exchange controls. Hopefully, inflation should remain as the main objective; iii) An important trade-off: the multiple goal policy reduces the effectiveness of the Central Bank’s key role in managing expectations; iv) There will be an increasing need for additional monetary instruments over and above

The global financial crisis has made central banks in the advanced economies “rediscover” the importance of financial stability. In the emerging market economies, in contrast, central banks have a ...

The global financial crisis has made central banks in the advanced economies “rediscover” the importance of financial stability. In the emerging market economies, in contrast, central banks have always regarded financial stability as one of their central responsibilities. In fact, a number of monetary policy instruments now called “heterodox” or “non conventional” in the context of the advanced economies, have been utilized for decades by central banks in emerging markets (e.g., liquidity or reserve requirements). The recurrent episodes of financial turbulence forced central banks in emerging markets to focus on financial stability, while in the advanced economies (under the influence

Central banks are now being given the task of maintaining financial stability as well as hitting inflation targets. With two objectives there needs to be, optimally, two instruments that can be used ...

Central banks are now being given the task of maintaining financial stability as well as hitting inflation targets. With two objectives there needs to be, optimally, two instruments that can be used separately for those purposes. It remains essential for central banks to predicate interest rates primarily for the achievement of stable prices, i.e. hitting the inflation target. The need is to find an additional set of instrument(s) that can allow them simultaneously to maintain financial stability. Such instruments have been identified, and include such measures as state-varying capital and liquidity ratios, loan-to-value and loan-to-income ratios in the property market,

The Challenge Unconventional monetary central bank policies after the GFC (i.e., Fed’s QEs and ECB’s outright monetary transactions) have supported asset prices and restored some market confidence so far, but will they succeed in engineering more robust and sustainable economic growth, employment, and financial stability over the medium term? If yes, “inflation targeting” would surely loose its flavor, but if no, should central banks return to “inflation targeting” framework as a means to restore economic and financial fundamentals? Unconventional monetary policies are unlikely to succeed in restoring robust economic fundamentals and lasting financial stability over the long term. In the

Central Banks have to further develop a fully-flexed framework of macroprudential surveillance. This framework has to allow for a broad assessment for the build-up of financial imbalances even if infl ...

Central Banks have to further develop a fully-flexed framework of macroprudential surveillance. This framework has to allow for a broad assessment for the build-up of financial imbalances even if inflation and inflation expectations remain subdued. This monetary policymaking strategy should also include a profound surveillance of money and credit developments and crosscheck the results against other analyses. This guarantees the symmetry of policy in expansions and contractions. ”Ultimately, this cross-check leads to a better assessment of the correctness of the policy stance. Early indications that a process of surging equity or house prices in the euro area might be interacting

The global financial crisis has shaken the foundations of the deceptively comfortable pre-crisis central banking world. Central banks face a threefold challenge: economic, intellectual and institutional. This essay puts forward a compass to help central banks sail in the largely uncharted waters ahead. The compass is based on tighter integration of the monetary and financial stability functions, keener awareness of the global dimensions of those tasks, and stronger safeguards for an increasingly vulnerable central bank operational independence.

Related Challenges

The Great Recession of 2008–09 has cast doubt on the broad consensus among economists and policy-makers that inflation targeting by central banks leads to desirable macroeconomic outcomes. Indeed, ...

The Great Recession of 2008–09 has cast doubt on the broad consensus among economists and policy-makers that inflation targeting by central banks leads to desirable macroeconomic outcomes. Indeed, many analysts suggest that the loose monetary policy stance of the US Federal Reserve was one of the main causes of the financial crisis and the economic downturn that followed.